Business context and reporting period
This is SMART Global Holdings, Inc.’s unaudited Form 10-Q for the quarter and six months ended February 28, 2020; it is not filed under the name Penguin Solutions. The company designs and manufactures memory, computing and storage products and related services. Its three reported segments are Specialty Memory Products, Brazil Products and Specialty Compute and Storage Solutions (SCSS). Prior-year segment results were recast to reflect the new segment structure.
Financial performance and liquidity
Amounts below are in U.S. dollars; financial statement amounts are in millions except per-share data.
| Metric | Q2 FY2020 | Q2 FY2019 | Six months FY2020 | Six months FY2019 |
|---|---|---|---|---|
| Net sales | $272.0 | $304.1 | $544.1 | $697.9 |
| Gross profit | $51.5 | $57.1 | $105.8 | $142.2 |
| Gross margin | 18.9% | 18.8% | 19.5% | 20.4% |
| Operating income | $8.2 | $22.5 | $14.0 | $70.3 |
| Net income (loss) | $(9.7) | $12.8 | $(9.5) | $43.8 |
| Diluted EPS | $(0.41) | $0.55 | $(0.40) | $1.88 |
| Operating cash flow | Not stated for quarter | $48.6 | $74.4 |
- Six-month operating expenses rose to $91.8 million from $72.0 million, including higher R&D and SG&A associated mainly with the SCSS acquisitions, integration and facilities costs.
- At February 28, 2020, cash was $141.9 million, current assets $549.9 million and current liabilities $277.2 million; current ratio was approximately 2.0. Inventory was $161.4 million, up from $118.7 million at August 30, 2019.
- Reported debt was $193.1 million net of discounts and issuance costs, comprising $191.6 million long-term and $1.5 million current. The company had $250 million principal of 2.25% convertible notes due 2026 and $1.5 million outstanding under a Brazilian development-bank loan; the prior $208.5 million term-loan principal was repaid in February. No revolving borrowings were outstanding.
- Six-month investing cash outflow was $9.3 million, primarily capital expenditures. Financing cash inflow was $11.8 million after note issuance, debt repayment and capped-call purchases. Cash increased $43.7 million overall, including a $7.5 million adverse exchange-rate impact.
Material changes versus prior comparable periods
- Sales fell 10.5% in the quarter and 22.0% for the six months. Lower Brazil and Specialty Memory sales more than offset growth in SCSS, which benefited from the July 2019 acquisitions of SMART EC and SMART Wireless.
- Brazil product sales declined 33.6% for the quarter and 44.7% for the six months, principally due to sharply lower average selling prices for mobile memory and DRAM. Specialty Memory sales also declined; SCSS revenue increased 52.1% and 43.1%, respectively.
- Six-month gross margin decreased to 19.5% from 20.4%, reflecting fixed manufacturing costs on lower Brazil revenue and higher SCSS costs. Quarterly gross margin was broadly flat.
- Six-month net loss included a $6.6 million loss on extinguishment of debt and a $4.8 million capped-call fair-value loss, as well as foreign-exchange losses. Net interest expense declined versus prior year.
- Operating cash flow declined by $25.8 million year over year. Inventory build and receivables used cash, partly offset by growth in accounts payable; management attributed inventory and payable changes in part to the transition of inventory from contract manufacturers and higher program purchases.
Outlook, risks and unusual items
- Management said existing cash, the revolving facility and operating cash generation were expected to fund operations for at least the next 12 months. No specific revenue or earnings guidance was provided.
- COVID-19 had not yet caused significant operational or supply-chain disruption as of the filing, but management warned of potential effects on suppliers, manufacturing, product development, customer demand, shipments and financial markets. The impact was not quantifiable.
- Brazil’s electronics tax-incentive framework changed effective April 1, 2020, replacing certain tax reductions with financial credits tied to R&D investment and sales. The company warned that replacement incentives may not provide comparable benefits and that regulatory or compliance changes could affect demand, margins and cash flows.
- Brazil foreign-exchange exposure is material: approximately 35% of six-month FY2020 net sales originated in reais, compared with 50% in the prior-year period. The company reported $2.1 million of six-month foreign-exchange losses.
- The $250 million convertible notes carry a 2.25% coupon, but accounting accretion raises the effective interest rate to 7.06%. Conversion, fundamental-change repurchase obligations and capped-call terms may affect liquidity, dilution and reported results. A March 2020 shareholder vote subsequently enabled potential share settlement of capped calls.
- The company disclosed a Brazilian import-duty assessment of approximately $1.3 million including interest and charges; it considered a material loss remote. It also described ongoing SanDisk indemnification claims, for which the potential loss was not estimable. No liability was recorded for product indemnities.
- After quarter-end, the revolving credit facility maturity was extended to March 2025 and its pricing and certain covenant terms were amended. Management reported disclosure controls were effective and no material change in internal control during the quarter.
Most important facts for investors to verify
- Whether the steep decline in Brazil and Specialty Memory selling prices and sales stabilizes, and whether SCSS acquisition growth can offset those declines profitably.
- Whether operating cash generation improves as inventory rises and working-capital balances shift; review inventory quality, customer collections and supplier concentration.
- The terms and cash implications of the new convertible notes, including conversion settlement, potential repurchases, and the relationship between $250 million principal and $191.6 million net carrying value.
- The final effects of Brazil’s April 2020 incentive changes, related R&D compliance obligations and recovery of Brazilian ICMS tax credits.
- The duration and operational and demand effects of COVID-19, which were uncertain at filing, along with subsequent developments after February 28, 2020.